MH Dispute Resolution

Thursday 9 November 2017

Contractual discretion – not an absolute

It is common in commercial contracts for one party to be given the power to make a determination eg. as to whether certain conditions have been sufficiently met as a precondition to some contractual entitlement due to the other party. Even though the relevant contractual clause may not impose express limits on the exercise of the discretion, the recent High Court case of Watson et al v Watchfinder.co.uk Limited [2017] EWHC 1275 serves as a reminder that the party with the power to make the determination should not fall into the trap of assuming that they have absolute discretion in the exercise of this power.

In this case, an option agreement contained a clause which provided that three individuals seeking to exercise their option to purchase shares in Watchfinder.co.uk Limited (“Watchfinder”) could only do so with the consent of the majority of Watchfinder’s board. The Watchfinder board, who appeared to be under the impression that they had an absolute right of veto over the exercise of the option, decided against giving consent after a board meeting which the court found had considered the matter only briefly, without proper information being provided to board members and without consideration being directed to the relevant issues.

The court held that, as a matter of construction of the relevant clause, it did not give an absolute and unfettered right to the board members to veto the exercise of the option. The board had a discretion which had to be exercised in accordance with what has become known as the “Braganza Duty” (after the Supreme Court case which established it: Braganza v BP Shipping Limited [2015] UKSC 17) ie. in a way that is not arbitrary, capricious or irrational. The ultimate decision must be one that is not so outrageous that no reasonable decision maker could have reached it.

Further, the board had to satisfy certain procedural requirements in their decision making process. Those were that their decision making process must have:

Taken into consideration all the material points; and

Not taken into account any irrelevant points.

The Watchfinder board had, however, failed in the exercise of the discretion, both in the procedural requirements and in the ultimate decision which was found to be arbitrary. As a result, it was ordered that the board’s consent was deemed to have been given and the individuals were entitled to exercise their option.

This is an important example as to how the Braganza Duty may limit the extent to which a party has discretion under a contract such that what appears to be an absolute discretion may be nothing of the sort. It is important to be aware of this when negotiating contracts.

Further, any party exercising a contractual decision-making power should ensure that:

Any express contractual processes for decision-making are carefully followed;

If appropriate, a properly constituted board meeting is convened to discuss the exercise of the contractual discretion;

All material points are taken into account and irrelevant matters are discounted;

The ultimate decision is not one that no reasonable decision-maker could have reached;

A detailed record is taken of the decision-making process and the reasons for the decision; and